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Why Half of All Startup “Unicorns” Might Fail Within Two Years

2/26/2016

We’ve got a funny term in the startup world for a venture capital (VC) startup with an implied valuation of $1billion or more — a unicorn. Notably, this is because that valuation is based on the most recent round of funding, and when your valuation is that high, it’s a pretty elusive feat. Right now there are 89 unicorns based in the U.S. That’s up 178.125% over the last 24 months from just 32 in January 2014. America’s unicorns have a total implied valuation of $305 billion at present, this is also up 306.125% from their total implied valuation 24 months ago of just $75.1 billion. So, that’s an explosion in both the number of unicorns and their value.

I believe that this growth is a sign of a major shift in America’s private VC-backed technology start-up space. Already, we are seeing major signs that the U.S. unicorn bubble is getting ready to burst, which could cause half of all unicorns to die within the next 12–24 months. Essentially, because growth has been so rapid, there isn’t going to be enough room or sustainability for everyone to thrive. It’s a warning sign.

Just one year ago, only 5 or 6 start-ups were reaching unicorn status on a monthly basis. Since November of 2015, though, only 1 or 2 start-ups per month have become unicorns. Things are shifting.

What’s happening is basically that we reached a peak of unicorns cropping up, and now that peak is being balanced out by what might be a dramatic decline. In January 2016, despite one new U.S. start-up becoming a unicorn — the total value of America’s unicorns declined by a record $2.1 billion. In fact, over the last three months, despite four new U.S. start-ups becoming unicorns — the total value of America’s unicorns declined by $0.4 billion. That’s a big loss. Based on the numbers, things are going south for the unicorns.

One reason for this dramatic decline is the stunning “down round” announced by Jawbone. In April 2015, Jawbone raised $300 million at an implied valuation of $3.3 billion. They’d already burned through that cash in just nine short months, and were forced to raise another $165 million in January 2016. This time it was at an implied valuation of only $1.5 billion — bad news, because that’s a 54.55% drop in value in 9 months. It’s also potentially the sharpest rapid decline in the history of unicorns. Ouch.

This might be a foreboding sign of what’s to come for many additional unicorns. Another well-known U.S. VC-backed startup, Foursquare, was predicted to become a future unicorn. They had raised $50 million between December 2013 and February 2014 at a valuation of $650 million, which included a $15 million investment by Microsoft. Pretty solid. In January 2016, Foursquare raised an additional $45 million, but this time at an implied valuation of $250 million, a decline of 61.54% from its previous round. That’s a sharp drop, and the trend continues.

Over the last 24 months, a total of nine unicorns have completed IPOs to become publicly traded companies. Most recently, in November 2015, Square (SQ) completed its IPO. Before going public, Square was the 10th largest U.S. unicorn with an implied private valuation of $6 billion. That’s a pretty top notch title to have. However, this didn’t prevent them from the same downfall. Square filed to go public at an initial offering range of $11-$13 per share, but its IPO ended up pricing at only $9 per share. This gave Square an initial public valuation of only $2.91 billion, a shocking 51.56% below its final implied valuation as a private unicorn. Today, SQ trades for only $8.76 per share — with a market cap of $2.83 billion or 52.85% below its final private valuation. In other words, their valuation is half of what they expected or planned for it to be.

Most unfortunately, 78% of unicorns that have successfully gone public on U.S. exchanges over the last 24 months are now trading with market caps that are far below their final implied valuations as private unicorns.

The median unicorn to go public over the last 24 months is currently trading with a market cap that is down -30.49% from its final private valuation. So that’s what’s happening in the middle of the game, which paints a pretty sad picture for those at the top. Only Wayfair (W) and New Relic (NEWR) are currently trading at higher valuations than before they went public. Square (SQ), GoPro (GPRO), Hortonworks (HDP), and Box (BOX) are each currently worth between 45% and 56.3% less than their final private valuations. Both Hortonworks (HDP) and Sunrun (RUN) are now worth well under $1 billion. Things aren’t looking good.

These unicorns were the lucky ones. Unfortunately, for the founders of today’s remaining unicorns and their VC investors — it might already be too late for them to successfully exit their positions.

Over the last twelve months, VC backed IPOs have raised total proceeds of only $9.38 billion. This is down 43.32% from a trailing twelve month peak of $16.55 billion raised by VC backed IPOs in early 2014. While the supply of capital available for VC backed IPOs has declined drastically over the last 21 months, the total valuation of U.S. based unicorns has simultaneously soared. What this means is that there’s an increasing demand for investment capital that is no longer available.

If we take 20% of the total value of U.S. based unicorns and divide it by the trailing twelve month proceeds raised by VC backed U.S. IPOs, it would currently take an estimated 6 1/2 years for all U.S. unicorns to IPO — nearly 6X longer than 24 months ago and more than double the trailing 24 month median. The bottom line: with the unicorn bubble likely to go bust over the next 12–24 months, less than 1/4 of today’s unicorns are likely to achieve a successful exit for their investors at a $1 billion+ valuation.

Nearly half of today’s unicorns have huge cash burn rates and will go out of business completely if they don’t dramatically reduce their operating expenses in the short-term. This is where getting “lean” plays an important role. For most of these unicorns, even if they are able to successfully reduce their expenses enough to turn a profit, it will destroy the rapid growth rates that led to them achieving their current high valuations. The best case scenario for the majority of today’s unicorns that actually have viable businesses will be that their valuations drop by 50%-90%. Unfortunately, the numbers tell the truth. But, knowledge is power. You can plan ahead and make strategic and well-informed moves to make sure you avoid these pitfalls.

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